Last week, global equity markets staged a partial recovery after president Trump announced that most higher rates of tariffs announced the previous week would be postponed for 90 days pending negotiations. The S&P500 jumped 9.5% on the news.
When there’s turmoil in financial markets, investors usually seek the safety of US Treasury bonds. But last week they sold off, triggering concerns that stress in the world’s safest, most liquid asset could spark problems in other parts of the financial system.
Despite a relief rally after Trump’s announcement, markets remain edgy. US equities sold off on Thursday and Friday, Treasury yields remain close to last Wednesday’s highs and the US dollar has sunk to a three-year low against the euro.
The highest tariffs have been postponed for most countries, but not China. A new 125% tariff on Chinese goods is in addition to the previous 20% tariff, taking the rate to 145%. Most countries face a 10% tariff, though cars, steel and aluminium are subject to 25% tariffs and goods from Mexico and Canada not covered by the USMCA trade deal pay 25%.
However, US commerce secretary, Howard Lutnick, suggested yesterday that these products would be subject to semi-conductor tariffs “in probably a month or two.”
The 90-day delay in the implementation of higher tariffs, above 10%, is a temporary reprieve for most of America’s trading partners but not for the US consumer. Much higher tariffs on China, America’s largest trading partner, mean that the overall tariff rate on US goods has risen as a result of last Wednesday’s changes, to 27% according to the Yale budget lab (YBL). This is a ten-fold increase in tariffs since the start of the year and takes tariffs to the highest level since 1903. (The YBL figures exclude the effects of Friday’s exemption of consumer tech from tariffs).
The Petersen Institute for International Economics, notes that US tariffs on Chinese products are more than 40 times higher than before the US-China tariff war started in 2018 and six times higher than when the second Trump administration began in late January. With a tariff rate of 145% many US consumers and businesses will simply switch away from Chinese products.
YBL has modelled a decline in China’s share of US imports from a current 14% to 4%, which, by reducing China’s weight in calculating the overall tariff rate, would give a lower effective rate of 18.5%. The redirection of spending away from imports subject to the highest tariffs lowers the effective tariff rate but leaves US consumers and business paying the highest tariffs since 1930.
Tariff increases have already taken effect and are likely to feed through quickly into prices. Given that goods imports account for about 11% of US GDP the effects are likely to be material. The YBL estimates that tariff rises imply a 2.9% increase in consumer prices at a time when US inflation is running around the 2.5% mark.
The pause in higher rates of tariffs leaves what Sarah Breeden, deputy governor for financial stability at the Bank of England, described last week as “the chilling effect of trade policy uncertainty on firms and consumers.” Unprecedented is an overused word, but it feels right today. A measure of policy uncertainty created by US academics, shows US trade policy uncertainty reaching the highest level in the index’s 40-year history in March (this reading was taken before the announcement of universal tariffs and then their partial postponement).
Last week, Deutsche Bank summed up the challenges as, “crippling policy uncertainty, haphazard tariff rate calculations [and] a partial loss of confidence in US institutional norms.”
Uncertainty weighs on financial markets, confidence and activity. These effects were on display in financial markets last week, with institutions shifting at pace into safer, more liquid assets. Unchecked, such moves tend to result in a tightening of credit conditions for households and corporates.
Recent events have fed through to US consumers. The Michigan consumer confidence reading for April, released on Friday, showed confidence at the second lowest level since the series started in 1978. US consumers are braced for a surge in inflation, with expectations for US inflation in one year’s time rising to 6.7%, the highest reading since 1981. Expectations for unemployment rose to the highest level since the financial crisis in 2009, a year which saw US unemployment peak at 10%.
Households tend to react to uncertainty by building up savings and delaying consumption, particularly on ‘big ticket’ items such as cars and home refurbishment.
Businesses react in a similar way. A 2013 Bank of England paper noted how uncertainty delays production and investment decisions and causes some of most productive firms to delay entering new markets at home and overseas. Uncertainty also encourages employees to sit tight in their current jobs, and deters firms from hiring, outcomes which, the Bank observes, weakens the matching function of the labour market and undermines productivity.
Brexit provides a case study in the impact of uncertainty on business. In 2019 the Bank of England used data from Deloitte’s CFO Survey to examine the relationship. In a speech drawing on the research, Michael Saunders, then a member of the Bank’s Monetary Policy Committee, noted that CFOs who reported elevated levels of uncertainty were far less likely to prioritise expansionary strategies such as increasing capital expenditure. The impact on investment is likely to have been material. In 2023 the UK’s National Institute for Economic and Social Research estimated that Brexit had reduced the level of UK business investment by over 12%.
Our latest UK CFO Survey, released today, shows that even before the announcement of universal tariffs on 2 April, UK CFOs had become more defensive, with a heightened focus on cost control (the survey period ran from 18-31 March). CFOs identify geopolitics, including tariffs, as the biggest external risk facing their business, with cyber-attacks in close second place, while concerns about US growth have risen to the highest level since we first asked the question in 2020.
Economists have been scrambling to incorporate the effects of recent volatility and uncertainties into their growth forecasts with predictable results.
Consensus, or average forecasts for US GDP growth this year have fallen sharply, from 2.2% in February to 1.4% in April. This average includes forecasts made before last week’s events and is likely to fall further as economists revise their forecasts. Goldman Sachs, which, at the time of president Trump’s inauguration in late January, was forecasting US growth of 2.4% this year, last week downgraded its forecast to 0.5%. Goldman assigns a 45% probability to the US falling into recession this year.
Forecasts for most other major economies are declining, although the downgrades are smaller than for the US.
China faces by far the highest tariffs and is therefore likely to see its exports to the US decline precipitously. However, Chinese exports of goods to the US account for just 3.0% of China’s GDP suggesting that the impact of tariffs on the Chinese economy may be contained. Among major economies, Mexico is most exposed to US trade (exports to the US make up 33% of Mexican GDP), Vietnam is in second place (25% of GDP) and Canada in third place (20% of GDP).
Uncertainty and disruption to trade tend, as the pandemic and its aftermath illustrate, to weaken growth and push up prices. But the effects are more chaotic and messier than this simple relationship suggests.
Imports into the US are likely to surge as companies and consumers seek to avoid even higher tariffs in three months’ time (The Financial Times reported last week that the cost of flying goods from China to the US has risen by almost 40% in the last four weeks). US households, despite being downbeat about the economy, are likely to pre-purchase goods which are due to face much higher tariffs.
It’s a different story for China. With 145% tariffs, Chinese exports to the US are likely to shrink quickly, causing disruption and supply bottlenecks. The Financial Times reports that shipping companies are facing a growing number of cancellations of transpacific orders, a trend which they expect to continue.
Reducing dependence on China, America’s main trading partner, is not straightforward.
In what seems like a clearcut case of economic ‘decoupling’, the US has already reduced its direct reliance on imports from China by approximately one-third over the last decade. But the gap left by Chinese exports has been filled by goods from alternative ‘connector’ nations, such as Vietnam and Cambodia. Much of which is being shipped to the US from such connector nations is either made in Chinese-owned factories or uses Chinese made components.
A Federal Reserve study last year found that, even as China’s share of US imports has declined, the proportion of imports into the US which were made in China or by Chinese-owned companies overseas has risen. On this measure the US has become more, not less dependent on China.
By committing themselves to rules, such as targeting a certain rate of inflation or signing trade agreements, governments aim to foster confidence and growth. Recent events are a reminder of the effects of sudden and significant rule changes.
A personal view from Ian Stewart, Deloitte’s Chief Economist in the UK. Subscribe and/or view previous editions of the ‘Deloitte Monday Briefing’ here.